Decentralized Investment and Quality Decisions
In Common-Pool Networks*
Manuel A. Abdala
Pablo T. Spiller
1. Introduction
During the last two decades network industries throughout both the developed and
developing world have witnessed a profound degree of unbundling, privatization and
increased competition. Although overall successful, these experiments have encountered
difficulties in establishing adequate rules of the game for decisions that require a high level of
coordination among the multiple participants sharing common-pool resources.
When organizing diverse network activities with multiple agents such as the operation and
expansion of an electricity grid, management of passenger train timetables, waterways,
irrigation systems, groundwater basins, fisheries, etc., countries have often resorted to
centralized solutions. Centralized or administrative solutions have two principal attractions:
first, they save on transaction costs that multiple agents would have to incur to get organized;
and second, they allow a more direct regulatory control over activities that typically require
government intervention because of externalities, free riding, and property rights problems.
Yet in network systems where competition has flourished, these same elements of
centralized, regulatory decision-making may create additional distortions and transaction
costs that may actually end up hurting the development of these industries. This happens,
for example, when a centralized agency imposes a particular allocation of investment costs
among electricity grid users that is deemed unfair for a set of parties. Or when a standard is
set for the level of reliability (quality) of the pool that is adequate for some users but may
send wrong incentives for others. The distorting elements are normally associated with
information asymmetries. Investment and quality decisions that should be taken by private
agents are either delayed or not incurred because the centralized agency fails to internalize
the true preferences of network users.
Complex meshed networks require decisions that affect multiple users, whose relationships
could be either complementary (such as a port and shipping companies in waterways),
competitive (electricity generators) or both. When the structure of the network (either its
quality or size) is affected, externalities may abound and both present and future users get
affected. In network industries where open-access principle prevails, as in electricity,
property rights and free riding issues emerge as a potential barrier to optimal investment
decisions.
In this paper we explore and analyze features and experiences of decentralized mechanisms
that put in place governance structures for network industries with common-pool values. The
idea behind decentralized mechanisms is that a certain coordination problems can be best
dealt through self-enforcing contractual arrangements among network users, with minimum
regulatory oversight. In the context of transaction cost theory, Menard (2000) defines selfenforcement as “… a set of clauses based on mutual consent among partners with no
arbitrariness in their implementation and, therefore, no need for intervention of a third
party…”1. In our context, the decentralized mechanism is not as pure as the definition above.
Rather, given the specificity of assets and hold up problems that are so characteristic in
network industries, self-enforcement will have to be backed up by a third party who could
intervene to solve potential conflicts. In other words, procedures on how to govern the
decentralized mechanism are agreed ex-ante by the parties, but such procedures foresee
the resort to public enforcement in case of major disputes.2
Decentralized Investment and Quality Decisions in Common-Pool Networks
The challenges of any decentralized mechanism would be not only to deal with the
transaction costs of getting grid users organized, but also to provide effective solutions to
problems such as externalities, economies of scale, property rights, free riding, as well as
allocative, cost, and dynamic efficiency associated with investment decisions.
We focus our main attention and examples on electricity networks, but the main ideas could
be applied to other network environments as well. Several studies have addressed the issue
of self-governance and self-regulated institutions,3 but very few have been applied to
competitive network industries. Ostrom (1990) has analyzed empirical examples of
successful and unsuccessful efforts to govern and manage natural resources through the
use of self-organization and self-governance in common-pool resource situations.4 Ravnborg
and del Pilar Guerrero (1999) examine watershed-level qualities as a common-pool resource
problem that could be solved through coordinated collective action by land users5. Tang
(1992) describes the typical collective-action situations faced by irrigators and examines the
role of local, self-governing organizations in resolving collective-action problems in irrigation,
based on case studies of forty-seven community, bureaucratic, or local-government
sponsored irrigation systems in a number of countries.
Barker, Tenenbaum and Woolf (1997) have compared self-governance mechanisms for
electricity pool organization in four different cases,6 but their focus is different from ours.
They examine the degree of autonomy, governance and regulatory arrangements within the
organization of the pool company itself.
In a more akin research path on network utilities, Abdala and Chambouleyron (1998) have
proposed a decentralized system for regional transmission investment and following this idea
IDIED (1999) has developed a similar scheme for decentralized investment decisions for
waterways private investment7.
The main thrust of this paper is that decentralized solutions work much better than
centralized ones. Rent seeking and politicization is avoided at much lower costs. Problems
of free riding and the potential raising of entry barriers may remain. The former can be
handled by better self-governance procedures, while the second may require antitrust
supervision. Both of these problems have been handled in the examples we present here, of
the FREBA in the Buenos Aires Province in Argentina, and the MACQS in New Zealand. We
believe these two examples show the way for further decentralized mechanisms to develop
throughout network utilities.
2. Centralized vs. Decentralized Solutions
Problems with centralized decisions in electricity networks
Investment and quality decisions may cause positive or negative externalities to electricity
agents. These agents can be competitors, providers or clients of those who would like to
initiate a change in quality or undertake a new investment project. In electric networks,
externalities arise when, for example, the existing capacity of a line diminishes/expands due
to a new project. Also, externalities take the form of quality aspects of the network, through
changes in system reliability.
It is difficult for a centralized agent to assess the preferences of investors when considering
the addition of a new transmission line, or of users when assessing the appropriate quality
standards on common-pool resources. First, beneficiaries of new transmission investment
belong to different classes of stakeholders (ISO, transmission firms, generators, distributors,
dealers, etc.) who are unlikely to have similar risk profiles, sector-specific risk premia, and
Abdala and Spiller
hence discount rates. In addition, transmission stakeholders are likely to have different views
on the transmission asset utilization and the stream of economic benefits associated with any
particular investment or quality decision.
Similarly, quality preferences differ among grid users. Common quality standards, for
example, will be very different for a supplier or distributor that faces strong penalties for loss
of load (LOL) – whether regulated or commercially determined, than for a one that does not
carry penalties at all.
If quality is determined centrally by government or by an ISO type institution governed by
government control, who bears the costs of common quality being too low or too high? How
does the centralized decision take into account what the market wants in terms of common
quality? Who have the responsibilities for achieving common quality levels? How are these
levels determined? Does the regulator frequently revise quality standards?
Some countries have left transmission investment and quality decisions within the domain of
a transmission monopoly.8 Here, the most relevant question is how investment (or additional
costs due to increased quality) will be recovered through the tariff structure (i.e. Colombia,
Chile). There are several problems with this approach:
a) Tariffs may be too high and by-pass may not be feasible. If bypass is not possible,
rents from other parts of the production chain will be transferred to the
transmission monopoly (i.e. Colombia).
b) Tariffs may be too high and by-pass is feasible. Bypass could be efficient or
inefficient (i.e. Chile’s Colbún competing transmission line is an example of
inefficient bypass).
c) Tariffs may be too low, in which case investment will not take place or will be
substantially delayed.
d) Investment decisions are not cost-efficient, as the monopoly has no incentive to
cut down on construction costs.
Other countries have converted electricity transmission into a more contestable market.
Argentina, New Zealand, El Salvador, and certain regions in the US designed more
competitive environments for transmission operation and environment. The key feature is
that new entrants are allowed to the transmission business. Yet free entry will not be a
sufficient condition for success, since - for the reasons mentioned above: externalities,
property rights, free riding - the way the allocation of investment and quality costs is made is
equally important.
Transmission congestion contracts (TCCs) have also been recommended as a remedy to the
property right and free riding problems associated with transmission investment. A TCC from
node A to node B would give a user the right to collect congestion rents due to flows between
these two nodes. Users that congest a line would generate congestion rents that would
accrue to TCCs holders, thus sending right economic signals to investors.9 TCCs can be
seen as way to allocate financial property rights among grid users who could either use or
trade them in a secondary market according to actual use of the network.10
Nevertheless, TCCs does not address the issue of coordinating network users’ preferences
and are only a partial remedy to protect ownership rights and free riding, for at least three
main reasons:
a) Determining the nominal capacity in meshed networks is not an easy task.
Capacity depends on loop flows, time of day, and other factors.
The
administration of TCCs becomes very cumbersome in meshed networks since it is
Decentralized Investment and Quality Decisions in Common-Pool Networks
not possible to define available physical transmission capacity in a way that can
be translated to tradable property rights.11
b) Since congestion rents collected trough TCCs depend on spot prices of electricity,
market shocks would put at risk the ability of TCCs to recover capital costs12.
c) Congestion rents do not recoup all costs, in particular because congestion is
alleviated or even eliminated right after investment takes place.
Alternative ways of granting property rights have been thought of through the use of
transmission capacity rights (TCRs), or capacity reservations. Granting rights over
incremental line capacity could be achieved without hurting the open access principle13.
Moreover, if capacity rights are auctioned under certain rules, grid users have a chance to
reveal true preferences in the auction. A problem remains, though, with the implementation
of TCRs, since, as with TCCs, the mechanism does not work well in meshed networks where
measurement of incremental capacity becomes obscure.14
Other centralized solutions involve quality and investment decisions taken by the system or
pool operator, with participation of transmission companies15.
Decentralized mechanisms
For decentralized mechanisms to be better placed to solve this problem they will have to
promote self-revelation of preferences among grid users’ preferences.
For this purpose, a self-governance structure, with self-made arrangements among grid
users will have to have the following features:
a)
b)
c)
d)
e)
f)
Minimal regulatory oversight to limit the politicization risk
Institutionalization of collective choice
Successful proposals should require substantial support among users
Veto power should be granted to protect minorities
Compensation to those receiving negative externalities (either directly or indirectly
through voting rights)
To avoid allocative inefficiencies, the mechanism should be subject to antitrust
enforcement.
But even if all these features are taken into account, this type of mechanism has also
potential drawbacks. Among those are:
a) High transaction costs: To set up new institutions and get agreements among
parties with divergent interests.
b) Difficulty to pass successful proposals: Tyranny of the status quo. When strong
majority is required to get consensus, it may be difficult to alter the status quo.
c) Inefficient outcomes: Although closer in conception to a market solution, the
decentralized mechanisms provide no guarantee that an efficient outcome will be
achieved.
d) Free riding problems: Depending on the type of decentralized arrangements, free
riding may not be fully eliminated.
e) Antitrust exclusion practices: In particular, there is the risk that members of
decentralized agencies that have self-regulatory powers perceive themselves as a
“club” and act accordingly to exclude competitors and new entrants to their
industries.
Abdala and Spiller
3. Two relevant decentralization examples
3.1. Case 1: Grid Expansions in Argentina. The Buenos Aires province initiative
3.1.1.Motivation
Electricity distributors and cooperatives of the Buenos Aires province16 decided to create a
regional board named FREBA17 to coordinate transmission investment and allocate its costs
on the basis of self-imposed rules.
Two major regulatory flaws triggered the need for coordinated private action. First, nationlevel procedures for transmission investment rely on a centralized administrative rule for its
most sensitive aspect: the allocation of costs among potential beneficiaries18. The rule is
flawed as cost allocation is based on an elementary measure of power flows. Hence, it does
not take into account externalities or users preferences, and produces unfair results that
distributors are not willing to accept. Veto safeguards to protect those receiving negative
externalities or those who had to bear a share of investment costs larger than their
willingness to pay are insufficient, and there are no provisions for compensation
mechanisms. Second, provincial-level regulation for pass-through of transmission investment
costs to end-user prices was also incoherent, as some distributors are allowed to transfer
these costs to tariffs, while others are not.
Therefore, the main motivation for private coordinated action was to overcome drawbacks
from centralized administrative rules for transmission investment.
3.1.2. The organization of a decentralized private forum
The regional forum FREBA was formally founded in December 1999 as a non-profit
organization with the main purpose of fostering coordination for transmission investment19.
FREBA membership is open to distributors, cooperatives and large industrial users from the
Buenos Aires province. It also allows transmission companies to play a counsel role,
granting them an affiliation that has no voting power within FREBA’s decision20.
To become a member, distributors have to make a mandatory contribution to a trust fund
called FITBA21, and also bear the administrative costs of FREBA. The global level of
mandatory contributions for each year is determined as the minimum amount of funds that
are necessary to start up a list of transmission projects selected from a portfolio of initiatives
presented by FREBA members (under the modality of a BOM contract, financed in 10 years).
This global level is then prorated by the individual demand size (in MWh) for each distributor,
therefore determining the share of the mandatory contribution of each distributor22. Members’
contributions to FITBA are deposited in individual accounts, and determine voting rights
within FREBA’s Assembly. FREBA’s internal distribution of power, therefore, is related to the
physical size of distributors, provided that they have deposited the corresponding
contributions in FITBA.
Voting rights within FREBA’s Assembly are crucial to elect the Board of Directors (BD)
(renewable every two years) and its operative arm, the Technical Committee (TC). The BD is
composed of five representatives elected by the Assembly and the TC has seven
professionals named by the BD.
FITBA sources of funds is not only composed of contributions from FREBA’s members, but
also from a special tariff component charged to end customers. The funds collected in this
form are called “pass-through funds” and are to be used under special conditions (see
following sections).
Decentralized Investment and Quality Decisions in Common-Pool Networks
3.1.3. Project selection procedure
Initiatives
FREBA’s members present initiatives to the TC where projects are subject to a preliminary
evaluation. All initiatives must contain project characteristics information such as technical
description, trace, rights of way, environmental analysis, flow simulations, and the expected
physical impact on all grid users. They should also stipulate an estimate of the annual
cannon to be paid to the transmission company which would be in charge of constructing,
operating and maintaining the line under a BOM contract. The cannon is calculated as the
annual component of the estimated BOM contract fee, over a period of 10 years, at a preestablished discount rate set by FREBA23. The cannon listed for each initiative at the CT
preliminary examination becomes a reference for FREBA members as to initiators’ estimated
annual costs of the new project.
Consultation and compensation devices
Once the CT has examined initiators’ proposals, it passes this information throughout
FREBA members, accompanied by a technical opinion. This consultation period has the
main purpose of letting grid users reveal their preferences to the extent that they may be
negatively affected by the project. In this case, a FREBA member can file either an objection
or a compensation request. Both petitions have to be based on sound grounds and are
subject to first-instance review by the TC.
The objection solicitation must prove that the project in question bears no positive social
benefit to the community of grid users of the province. For an objection to be automatically
approved, 6 out of 7 votes within the TC are required (very strong majority). On the other
hand, if the objection has the support of only three or less votes of the TC, the project would
continue with the selection procedure and the objection petition will be dismissed. In a
middle course, when an objection is supported by four or five votes (simple and strong
majority), the project is labeled as “conditional”, and the decision on whether it should be
objected or not goes on to FREBA’s Assembly. For a conditional project to be objected the
Assembly needs 30% or more of total votes. That is, for a controversial project to be finally
objected, it requires first, a majority opposition from TC opinions, and second, opposition
from at least a strong minority within the Assembly.
The compensation solicitation, on the other hand, allows grid users that may be negatively
affected by externalities to file a request for economic compensation. The request have to
sustained on technical and economic grounds, and a solicitation fee equivalent to 15% of the
amount of compensation is required to have the petition analyzed by the TC24.
For a compensation to be approved, the TC needs simple majority only (at least 4 of 7
votes). However, a positive TC decision on allowing compensation, does not mean
agreement on the amount solicited. If there is such disagreement, the TC informs the
solicitor on the amount authorized and asks him for consensus. If the solicitor is not content
with the decision, he could choose to submit a “referendum” to the Assembly. In this second
stage, the Assembly votes over the amount of the compensation, and simple majority are
needed to reach a decision. Therefore, for a compensation to be accepted, it requires simple
majority both at the TC and Assembly level, but the amount of compensation can be adjusted
within FREBA’s two-stage instances (TC and Assembly).
Competing projects that are mutually exclusive can be examined at the same time by the TC,
which has no power to make any selection among them. The TC can only make technical
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recommendations and comments about the nature of each competing project and will inform
so to FREBA members.
Economic revelation of preferences
Initiators will be the ultimate responsible for signing a BOM contract with a transmission
company. They will pay for the investment partly through their own sources, and partly
through the recovery of pass-through funds, once the works are finished.
Therefore, in a new project involving several grid users, initiators have to voluntarily structure
coalitions that would ex-ante settle their individual shares over total investment costs. An
important caveat for helping revealing true preferences and avoid free riding is that passthrough funds collected in FITBA are allowed to be reimbursed only to initiators, keeping
proportions to their individual share within the coalition. That is, there is a strong incentive
for a distributor to identify itself as a beneficiary of a new project and accommodate a
coalition, since otherwise pass-through funds collected from its clients will not be eligible for
use in such project. Pass-through funds collected from customers of distributor A could only
be used by such distributor. Thus, there are no direct cross-subsidies in the use of passthrough funds among distributors.
Another important element of this governance structure is that pass-through funds could be
used to finance only a partial amount (∼) of total investment costs. This feature is an
additional mean to guarantee the regulator that investment costs will be minimized (the other
important element in the same direction is the competition of transmission firms to get the
BOM contract). FREBA has proposed the provincial regulator that ∼ be equal to 0.9.
Once coalitions are structured and initiators have passed TC requirements, a special FREBA
Assembly is gathered to decide the final allocation of investment costs for each project. At
this stage, questions on conditional projects and referendums on compensations have all
been cleared. The special Assembly procedure is divided in three rounds.
In the first round, FREBA members can allocate their individual contributions to FITBA to any
of the list of projects that had cleared the TC examination. This first round may seem too
obvious, as initiators would allocate their funds to the projects they support, but one of the
purposes is to allow FREBA members that are not initiators to have an opportunity to
express economic preferences at this stage. For approval in this round, total funds already
deposited in FITBA and allocated to a particular project, should be sufficient to pay the first
installment of the estimated annual cannon. In addition, such allocation also commits the
member to pay similar amounts on the remaining nine years. Projects that did not get
enough financing support pass on to the second round.
In the second round FREBA members that still have available funds in their FITBA accounts
could voluntarily decide to lend money to initiators whose projects have fallen short of
funds25. If FITBA is also able to capture funds from third parties (external investors), such
funds will also be allocated to the “borrowing pool”. An auction is conducted to allocate funds
from this pool if the demand exceeds supply. The borrowing interest rate is the variable over
which coalitions will bid upon. There is a price floor on the interest rate, based on market
prices, and FREBA has a strong internal system of guarantees, so as to alleviate differences
on credit risk ratings among distributors26.
If a project does not get sufficient funds in the second round, a third round is open for
voluntary contributions to FITBA. Initiators could thus have a final chance to allocate
additional funds to the projects they support27.
Decentralized Investment and Quality Decisions in Common-Pool Networks
A particular situation could be expected if, at any point of the three rounds, two or more
competing projects get sufficient funds. Although quite unlikely, such economic dispute would
be solved by FREBA’s assembly with a strong majority support requiring 75% of votes to
decide on final approval.
Approved projects are then eligible for BOM contract public tender, to select a competitive
transmission company. These tenders have as base price the annual cannon set by
initiators. Competitive bids would eventually result on a cannon amount that is lower to the
reference price, provided that the FREBA reference discount rate is not substantially below
market prices and that project cost estimation were not downward biased.
3.1.4. Forum interfaces with the regulator
The whole FREBA mechanism requires an initial consensus with the regulator, because of
the presence of pass-through funds and the delegation of certain activities that are
traditionally conceived under the domain of the regulator, like evaluating the environmental
impact of a new line.
An important regulatory definition involves both the size of the total annual pass-through to
be deposited on FITBA, as well as the size of ∼. The government trade off here is quite
clear. It wants investment to take place, but at an optimal amount. It also wants to see
projects undertaken with cost efficiency, to avoid hurting captive consumers through an
excessive pass-through. In the FREBA mechanism, distributors have the incentive to
minimize costs, as they bear a portion of the investment costs directly. One should therefore
expect that the investment decision be taken optimally in dimensions such as price, location,
timing, and scale.
Minimum regulatory intervention takes place at least twice during the selection process.
First, before projects enter the special Assembly stage, the regulator makes sure that the
environmental impact analysis and other technical considerations have been
comprehensively evaluated. Second, the regulator could double-check that pass-through
funds are used correctly. For example, it could monitor that pass-through funds are not used
to roll in investments that have extra-regional beneficiaries28.
Finally, antitrust agencies could eventually act as watchdogs, to prevent exclusionary
practices that may limit competition between existing and future FREBA members.
3.1.5. Current experience and challenges ahead
It took about a year to get FREBA organized, and the forum is still in the process of polishing
up its internal rules. So far, distributors representing more than 70% of total provincial
demand have voluntarily joined FREBA, and it is expected that the rest will join afterwards.
Credibility of the institution has not been achieved yet, as the mechanism has not been fully
tested and is too young to be judged. The first project selection mechanism has not been
triggered yet, as governmental definitions on the total amount of pass-through were still
pending.
One area that may need further discussion is lack of agreement among parties to set up a
coalition of initiators, leading to free riding problems. It is suspected that in those projects
where a party has a major stake and interest in getting the project done, whereas the
other(s) only receives marginal benefits, the party with the small share may try to free ride by
Abdala and Spiller
not joining the coalition. Since insofar there are no mandatory rules of participation, there is a
concern on how potential conflicts of this nature could be solved.
Other regions with similar problems are looking into FREBA as a model for solving their
regional transmission investment deficit. If FREBA agreement turns into a success, this type
of decentralized mechanism could, in the medium turn, be converted into a broader
institution that set policies for common quality and security issues, for example. The
decentralization move could also challenge the existing incentives derived from centralized
rules for transmission grid operation. For instance, level of penalties and bonuses faced by
transmission firms for line availability, could be determined matching grid users’ preferences
about line reliability and costs of LOL29.
3.2. Case 2: Grid Quality Determination in New Zealand’s wholesale market
The widespread reforms in the electricity sector in New Zealand brought about a vertically
and horizontally fragmented industry, with TPNZ, the transmission company, at the center of
the system, with transmission and dispatch responsibilities.30 One of the key components of
New Zealand’s regulatory approach has been the emphasis of competition regulation over
industry regulation. Thus, as in the other utility sectors, the industry was essentially
deregulated but with the Commerce Commission having supervision responsibilities over
antitrust. Distribution companies were subjected to disclosure requirements, and TPNZ’s
tariff structure was subjected to substantial industry and Commerce Commission review.31
The industry created its own wholesale market (NZEM),32 its own metering and reconciliation
system (MARIA),33 and recently, its own way of determining wholesale quality (awkwardly
named MACQS).34 As it relates to the MACQS agreement, there was an industry concern
with TPNZ’s high cost structure, and in particular, that the fact that TPNZ determined the
wholesale electricity quality provided incentives to increase costs unnecessarily. The
industry, then, after several months of meetings reached a decentralized way of setting
quality at the wholesale level. As of today, though, this agreement may be jeopardized by
the new government’s decision to centralize the three governance structures into one under
government supervision – potentially defeating, by increasing rent seeking and politicization,
the effort undertaken by the industry over the last four years.35 Here we will summarily
present the industry’s way of determining quality responsibilities.
The industry first determined an Interim Grid Security Committee, composed of grid users
and TPNZ. It held weekly meetings for 10 months, and made institutional recommendations
to determine and implement quality aspects, including security. The results of these
recommendations were presented for approval to the Commerce Commission, and after
obtaining authorization, started operating, following the signing by the users, in November
1999.
The main institutional innovations as they relate to the determination of quality is, first of all,
that quality will be determined by the system users and not by a service providers. But that
is not the only innovations. Procedural innovations are fundamental as well, in particular, the
development of participative procedures, and the development of bilateral and multilateral
contracts with minimum performance standards for each party.
Figure 1 presents the main way by which the MACQS determines both quality and each
individual participant’s responsibilities.36
Decentralized Investment and Quality Decisions in Common-Pool Networks
Figure 1: Interactions between MACQS Members and CQC
MACQS
Members
Multilateral Contract
Performance Targets for the CQC
Real Time Operation to Meet Targets
•Accountable for Schedule & Dispatch
•Outage Coordination
•Grid Emergency Response
Advice on Standards to GSC
Complex Equivalence Judgments
Information provision
Administration
CQC
Security Contracts
Common Standards (in performance terms)
Minimum Scheduling and Dispatch
Ancillary Services (Transition) and Settlement
Ancillary Services Cost Allocation
Dispute Resolution
Equipment Capability Statements by Owners
Generation
Transmission
Demand
Asset Contracts
Requirement to hold a Security Contract
Asset Performance to meet contract performance objectives
Liability for Performance as contracted
Safety / Environmental
Asset Cost Recovery
The MACQS has two major institutions: the Common Quality Coordinator, CQC, and the
MACQS members, who are the buyers of quality. The MACQS members are essentially the
grid users, whether final users, generators, distributors, or transmission grid owners. The
CQC’s main responsibilities are specified in the multilateral contracts it has with the MACQS
via a deed between the Grid Security Committee (as representative of the MACQS
members), and in turn, the CQC enters into security contracts with asset holders, i.e.,
generators, transmission companies, and demanders.37 As Figure 1 shows, the multilateral
contracts requires the CQC to be accountable for real time operations, and in particular,
minimum quality targets are specified and penalties for deviation imposed. The CQC also
has responsibility for controlling the application of minimum operation standards by asset
owners. The multilateral contracts among the CQC and the buyers of quality, and the
“cascade contracts” among the CQC and asset owners, then, determine common standards,
individual asset owner requirements, and in particular, specifies conflict resolution
procedures.
Abdala and Spiller
The Grid Security Committee, in turn, is in charge of evaluating proposals for changing parts
of the MACQS. It also supervises the CQC contract arrangements, admits new members,
and appoints mediators for conflict resolution purposes. The GSC is composed of ten
members, nine of which are elected representatives, representing generators (three),
retailers, local networks, grid owners, domestic, commercial and industrial end users (one
each).
Each member of MACQS receives voting rights based on its demand or generation capacity
at the node. These voting rights – based on MW injection or offtake, are transferable, and
whoever holds the voting right is responsible for covering administrative costs.38 GSC
decisions must follow particular procedures. Figure 2 presents the GSC’s decision making
process.
Figure 2: GSC’s Decision-Making Process
GSC Issues Recommendation
Public Comment Period
2 GSC members
opposed
Resolution withdrawn
1 or less of members of
the GSC opposed
5% of votes
call for vote
No vote called for
25%+ reject
resolution
less than 25% against
Resolution Rejected
Resolution
accepted
Resolution
accepted
The main implication of the GSC procedures is that as it relates to common quality decisions,
it avoids both inefficient decisions, or rent seeking. For either one to take place, nine out of
the ten members must support the decision, the change must benefit at least 75% of the
voting rights, the losses to the 25% must not be too high (if these were high, they would buy
some of the rights from some of the members voting with the winning majority),39 and
furthermore, the Commerce Commission must allow it. Thus, serious inefficiencies or rent
seeking outcomes probably would not take place.40
To summarize, the MACQS is an institutional innovation that creates user participation in the
decision-making process concerning transmission quality. It assigns responsibilities to the
common quality coordinator; responsibilities arrived via a consensus building process. The
CQC, in turn, enters into contract with asset holders to motivate these to maintain and
operate those assets in ways that limit costs to the system. Important expansions that
benefits all are then implemented via the CGS procedures.
Decentralized Investment and Quality Decisions in Common-Pool Networks
4. Conclusions and challenges ahead
Two examples of decentralized systems in electricity grids were presented in this paper
(FREBA in Buenos Aires province, Argentina; and the MACQS in New Zealand). One
interesting common feature is that both initiatives emerged as an alternative to centralized
administrative rules, in search of fair outcomes, free of discretionary results that could be
imposed by a regulator. A remarkable point is that these innovative institutions developed
despite the presence of externalities, transaction costs, and other features that typically call
for regulatory intervention over transmission network facilities.
A natural consequence of self-governance in the use of a common-pool network is the
internalization of externalities. Key features for the organization to be effective are the
provision of incentives that lead to self-revelation of preferences, and the efficient resolution
of conflicts and negotiations among grid users. The examples examined here provided for
special compensation mechanisms to deal with externalities, either directly or through the
use of voting rights. Special voting provisions were considered to reach strong consensus
on decisions that are relevant for the management of the common network, such as
investment, quality, security, and reliability.
Actual performance of decentralized systems in electricity transmission remains to be
evaluated. One area of concern seems to be how to assure that a self-governance structure
will lead to efficient decisions. In this paper we do not evaluate whether decentralized
decisions are Pareto optimal. But the initiatives indicate that both regulator and private users
perceive that a decentralized arrangement is superior to the traditional form of organization.
So, even if only second-best efficiency outcomes were achieved, the more relevant question
is, are transaction costs lower than in the centralized alternative? We believe that in the two
examples analyzed the main challenge to transaction costs in the decentralized arrangement
may come through the presence of inter-temporal free riding behavior. As electricity
networks in competitive environments operate usually under the open access principle, new
grid users may benefit from investment for which they can not easily be forced to contribute,
unless there is some minimum property rights enforcement, through a public authority.
The free riding issue brings about the question on the degree of regulator’s supervision
required in decentralized institutions. Often times a decentralized institution may be required
to coexist with old-style active regulation of legal monopolies that require heavier regulatory
control. What type of precautions should a regulator take vis-a-vis a self-governed institution
such as FREBA or MACQS in this context? Should these be within the jurisdiction of industry
regulators or antitrust authorities? How would the mechanisms work with minimum public
oversight? What are the regulatory consequences of a self-governed institution in an
environment where regulatory enforcement is poor, due to a weak institutional endowment?
How much credibility is needed to reduce to public oversight? Could exclusion of newcomers
to the decentralized institution become an antitrust problem?
These concerns need to be explored and further investigated. It would be of help to the field
of industrial organization if experiments could be conducted to test the ability of selfgoverned institutions to work out negotiations, internalize externalities and solve conflicts in
complex environments such as electricity networks.
Abdala and Spiller
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Decentralized Investment and Quality Decisions in Common-Pool Networks
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1
Menard. C. (2000), page 242.
This specification corresponds to the so called “hybrid organizational forms”. See Menard (2000),
Williamson (1985, 1991).
3
See, for example, Ayres and Braithwaite (1992), Stephenson (1996) Steins and Edwards (1999),
Loehman and Kilgour (1998).
4
The author focuses on cases like the organization of mountain grazing and forest common-pool
resources in Switzerland and Japan, and some irrigation systems in Spain and the Philippines. There
are also analyses on a set of institutions to manage a series of groundwater basins located beneath
the Los Angeles metropolitan area, fisheries in Turkey; groundwater in San Bernardino County,
California; and fisheries and irrigation systems in Sri Lanka.
5
Experiences of a micro-watershed research in the Andean hillsides of southern Colombia are
narrated.
6
England and Wales, Victoria (Australia), Alberta (Canada) and the NordPool.
2
Abdala and Spiller
7
See Dinar and Loehman (1995) for numerous examples of coordinated efforts in the water
management field.
8
Hogan (1999) suggests that one way of dealing with the problem of the commons associated with
network externalities in competitive markets is to give the transmission company a monopoly with the
obligation to provide unlimited transmission services to everyone.
9
See the early works from Hogan (1992), and Chao and Peck (1996). Financial TCCs are also known
as passive rights (See Oren 1997). For a more recent work, see also, Chao, Peck, Oren and Wilson
(2000).
10
According to Hogan (1999), TCCs is the approach that dominates thinking in the United States and
stands behind the policy at the Federal Energy Regulatory Commission.
11
See Hogan (1999), Abdala and Chambouleyron (1999), and Oren (1997).
12
For instance, a fall in the cost of generation would cause a drop in the spot price (in a competitive
market) and thus entitle TCC holders to smaller-than-expected congestion rents.
13
See, for example, Tabors (1996) for a system of point-to-point capacity reservations.
14
For a proposal on TCRs sold through auctions, see Abdala, Arrufat and Torres (1997). The "Direct
Link" project between Queensland and New South Wales in Australia is an example of granting
property rights to incremental capacity (Hogan, 1999). Although, this is not a meshed case.
15
California is an example of a mechanism that attempts to be flexible and bring full participation to all
stakeholders, but yet final decisions are centralized by the ISO (Independent System Operator).
16
Composed of 9.2 million inhabitants in 303.000 square km of pampas, who consume about 9,500
GWh/year. Three private distributors concentrate two thirds of total provincial demand whereas the
rest is served by about 200 cooperatives.
17
FREBA: Foro Regional Eléctrico de la Provincia de Buenos Aires.
18
In Argentina, there are no major barriers to entry in transmission, other than the centralized
administrative rules for determining who ends up paying the investment cost for a new facility. A new
transmission firm can enter the market if it wins a competitive tender. The winner is the firm that bids
lower construction and operation costs. For transmission operation and maintenance the firm receives
revenue that is capped, and has to meet certain quality standards (including line availability) that are
subject to penalties and bonuses. For a more comprehensive description and criticisms of Argentine
transmission regulation see Abdala (1994), Bastos and Abdala (1996), Spiller and Torres (1996) and
Abdala and Chambouleyron (1999)
19
Previous ideas on the organization of decentralized regional forums for electricity transmission
appeared in Abdala and Chambouleyron (1998).
20
Generators were not invited to the Forum, as the province is an importer of energy from other
regions (provincial transmission lines basically configure a meshed distribution network in high and
medium tension levels).
21
FITBA is a trust fund specially created to finance transmission investment projects in the province.
It stands for Fondo Fiduciario para Inversiones en Transmisión en la Provincia de Buenos Aires.
22
Industrial users are not required to make mandatory contributions to FITBA.
23
Establishing a discretionary discount rate bears no economic effect at this stage, since the BOM
contract would be subject to competition among transmission companies in a public tender process
once FREBA approves the list of eligible projects.
24
The solicitation fee is totally reimbursed if the compensation is authorized. Otherwise, the CT will
deduct all administrative costs incurred to examine the petition, before reimbursement.
25
Initiators can borrow today to help finance the first installment of the estimated cannon, but they are
still responsible for financing (with own or external sources) the remaining installments for the
equivalent proportion of what they borrow today.
26
There is a triple-deck system of guarantees for a borrowing distributor. Own deposit to FITBA is the
first level, followed by its own pass-through funds and, finally, the faculty to exert a judicial order over
its electricity revenue collection.
27
Project approval in this round is made contingent to the deposit of the additional funds in FITBA
within 48 hrs following the special Assembly.
28
A similar situation was faced in the Argentine gas transportation sector, since rolling in investment
costs among domestic users for pipelines whose value was mainly associated to export projects, has
raised regulatory complaints.
29
In the Argentine regulation for transmission, norms are quite strict on penalties for line unavailability.
But distributors and marketers can not freely give incentives to transmission companies for different
levels of quality. Thus, there is a gap between supply and demand that is not well addressed by the
current means of centralized regulation.
Decentralized Investment and Quality Decisions in Common-Pool Networks
30
See Bergara and Spiller (1997).
For a chronology of the electricity reforms from 1994 to the present, see, Ministry of Economic
Development, Energy Resources and Safety, http://www.med.govt.nz/ers/electric/chronology/chronology02.html.
32
New Zealand Electricity Market, NZEM, the multilateral agreement under which most wholesale
electricity is bought by retailers and sold by generators on a half-hourly basis.
33
MARIA, the Metering and Reconciliation Information Agreement, which outlines the rules that, allow
a buyer and seller to form a contract to supply electricity.
34
The MACQS, or the new Multilateral Agreement on Common Quality Standards, which aims to
transfer responsibility for transmission supply quality to the industry (this responsibility currently lies
with Transpower).
35
See, Ministerial Inquiry into the Electricity Industry, Inquiry into the Electricity Industry: June 2000
Report to the Minister of Energy, at http://www.electricityinquiry.govt.nz/reports/final/index.html.
36
For details on the workings of MACQS, see http://www.gsp.co.nz/welcome.html.
37
In the interim, TPNZ is the Common Quality Coordinator.
38
Thus, final consumers may transfer their voting rights to distributors, brokers or any other agent.
39
Members may split votes, i.e., transfer one vote to one agent and another vote to another.
40
At the same time, the demands for changing rules are so difficult to implement that a potential
“tyranny of the status quo” may have been generated here.
31